In re Pioneer Health Services, Inc.

Citations: 570 B.R. 228; 77 Collier Bankr. Cas. 2d 1117; 2017 Bankr. LEXIS 939Docket: CASE NO. 16-01119-NPO JOINTLY ADMINISTERED

Court: United States Bankruptcy Court, S.D. Mississippi; April 4, 2017; Us Bankruptcy; United States Bankruptcy Court

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The Court denied in part the Motion filed by Pioneer Health Services, Inc. seeking to classify certain claimants, specifically three emergency room physicians (Dr. Lamar Brand, Dr. Vincent Barker, and Dr. Kevin Hayes), as critical vendors and to approve payments totaling $116,259.73 for their prepetition, unsecured claims. The Motion was heard on March 24, 2017, following an objection from the Official Committee of the Unsecured Creditors. Pioneer Health had settled its claims regarding Grist Oil before the Hearing, narrowing the focus solely to the physicians. The Court ruled that the physicians did not qualify as critical vendors. The ruling is documented in this Order, which does not address the settlement with Grist. Pioneer Health, which filed for chapter 11 bankruptcy on March 30, 2016, operates several hospitals in the southeastern U.S. and is in a liquidating chapter 11 case, actively marketing its assets, including the hospitals. Jurisdiction over the case is established under 28 U.S.C. § 1334 and it is classified as a core proceeding.

Pioneer Health has employment agreements with several physicians, including Dr. Brand, Dr. Barker, and Dr. Hayes, who provide medical services at its hospitals. At the time of the Petition, Pioneer Health owed money to these physicians under their contracts, which allow for termination by either party with prior written notice (30 days for Dr. Brand and Dr. Barker; 90 days for Dr. Hayes). Pioneer Health refers to these physicians as the "Affected Physicians" and asserts that their prepetition claims are mostly unsecured, though some may hold priority under the Bankruptcy Code. The Affected Physicians have expressed concerns about their job security without payment of their prepetition claims, prompting Pioneer Health to seek to pay these claims in full to prevent the termination of their contracts. 

Pioneer Health argues that the Affected Physicians are critical vendors, asserting that replacing them would be difficult due to their unique skills and dedication. Morgan testified that the loss of these physicians would severely impact hospital operations, with Dr. Brand and Dr. Barker admitting 95% of patients at Early Hospital and Dr. Hayes admitting 40% at Aberdeen Hospital. To manage cash flow, Pioneer Health proposed to make three equal payments to these physicians over three weeks. While the employment agreements may be considered executory contracts under bankruptcy law, Pioneer Health chose to classify the Affected Physicians as critical vendors due to the personal nature of their services. 

The Committee opposed this motion, noting its late filing—ten months post-Petition—and raising concerns that granting it could set a precedent for other creditors seeking critical vendor status. Morgan indicated that approximately 240 employees at the hospitals have also threatened to leave, highlighting the precariousness of Pioneer Health's situation.

Pioneer Health did not demonstrate in its Motion that the Affected Physicians, despite their employment agreements, have actually refused or are likely to refuse services if critical vendor payments are not made. Additionally, Pioneer Health failed to clarify how other unsecured creditors would be treated if these proposed payments proceed. Under Chapter 11, a debtor generally cannot make payments on prepetition claims without a confirmed reorganization plan or court-approved liquidation, as stipulated by 11 U.S.C. § 1129(b)(1). In specific cases, creditors essential to business operations may demand payment of prepetition debts before continuing to provide services, leading some courts to allow debtors to pay these unsecured claims prior to plan confirmation. However, courts have faced challenges in justifying deviations from the priority rules established in 11 U.S.C. § 507. Typically, courts permitting critical vendor payments rely on 11 U.S.C. § 105 and the necessity of payment rule, arguing that such actions are essential for reorganization goals. Pioneer Health's Motion presumes authority to bypass the priority scheme for general unsecured claims under certain conditions, contrary to Fifth Circuit case law suggesting that prepetition unsecured claims should not be elevated above other creditors. The court in CoServ highlighted the need for actions to be consistent with the Bankruptcy Code, stating that no provision allows for post-petition funds to satisfy prepetition claims without violating the established priority of creditors.

Preferring "critical vendors" raises concerns about overriding established congressional priorities. The CoServ court clarified that 11 U.S.C. § 105(a) is applicable only within the Bankruptcy Code's framework. To connect § 105(a) with the Doctrine of Necessity, the court referenced § 1107(a), which requires a debtor in possession to protect the estate's value, including that of an ongoing business. This duty may necessitate preplan payments to certain critical vendors under specific conditions. 

CoServ established a three-part test for identifying critical vendors: (1) the creditor must be essential for the debtor's operations; (2) failing to pay the creditor must pose a risk of significant harm or loss to the estate that outweighs the prepetition claim's amount; and (3) there must be no viable alternative to payment. The first criterion demands that the creditor be indispensable for profitable operations; the second requires proof of economic benefit or harm avoidance through the payment; and the third recognizes that alternative solutions, such as deposits or legal remedies, may exist.

In a case involving a vendor providing IT services familiar to the debtor, the court allowed payment of the vendor's prepetition claim, contingent on the vendor's continued provision of services. Conversely, in In re Kmart Corp., the Seventh Circuit limited the practice of designating vendors as critical based on insufficient evidence, emphasizing that § 105(a) does not permit bankruptcy courts to bypass prioritization rules established in the Code.

The Seventh Circuit rejected the doctrine of necessity as a valid justification for critical vendor payments, characterizing it as merely a means to bypass the Bankruptcy Code. However, it indicated that § 363(b)(1) could justify such payments under specific conditions: 1) the payments are essential for successful reorganization, 2) disfavored unsecured creditors would fare as well in reorganization as in liquidation, and 3) critical vendors would stop doing business if payments are not made. The court concluded that the critical vendor orders in question did not meet this test, leaving the permissibility of such orders unresolved.

In Czyzewski v. Jevic Holding Corp., the Supreme Court ruled that bankruptcy courts cannot approve non-consensual structured dismissals that alter the priority scheme of the Bankruptcy Code, differentiating critical vendor orders from structured dismissals as the latter lacks significant bankruptcy-related justification. This precedent suggests a restrictive view on critical vendor payments.

In the current case, the Court found that Pioneer Health failed to demonstrate that the Affected Physicians were critical vendors. Pioneer Health did not provide evidence of the physicians' unique qualifications or show that they would leave without payment, as no direct testimony or affidavits were presented to support these claims. Furthermore, alternatives to full payments exist for Pioneer Health to manage its dealings with the Affected Physicians, who may also be in violation of the automatic stay under 11 U.S.C. § 362(a)(6).

The Court addresses potential threats by Affected Physicians to leave the Hospital to compel Pioneer Health to pay their prepetition claims, which contradicts their employment obligations. If Pioneer Health does not act, the Committee is authorized to pursue legal action against the physicians for violating the automatic stay under 11 U.S.C. § 362(k), which allows for recovery of damages, including attorney fees and potential punitive damages for willful violations. The Court questions the justification for Pioneer Health’s proposed critical vendor payments, as they might allow physicians to terminate their contracts immediately after receiving payment, thus providing no commitment to continue services.

The Court emphasizes that Pioneer Health failed to negotiate benefits for the bankruptcy estate, raising concerns that such payments could encourage other creditors to demand immediate payment of their prepetition claims. Acknowledging the Fifth Circuit's skepticism toward critical vendor orders and recent Supreme Court rulings against non-consensual structured dismissals that violate priority rules, the Court finds no substantial justification for classifying the Affected Physicians as critical vendors. Consequently, the Motion regarding the Affected Physicians is denied. The Court does not comment on the issue of wage priority claims or any potential violations of the automatic stay. It is noted that the employment agreements were not presented as evidence, and they appear to have been made with business entities linked to the physicians rather than directly with them. The Committee submitted relevant bankruptcy schedules as evidence, and testimony indicated that some of the physicians also treat patients at a clinic operated by Pioneer Health.

Section 507(a)(4) of the Bankruptcy Code prioritizes employee claims for prepetition wages, salaries, and commissions earned within 180 days before the bankruptcy petition filing or business cessation, with a statutory cap of $12,475 for cases from April 1, 2013, to March 31, 2016, and $12,850 for cases starting on or after April 1, 2016. Pioneer Health contended that paying the prepetition claims of the Affected Physicians, who are independent contractors, would not disrupt the priority scheme, amounting to approximately $60,000 at stake. However, their independent contractor status means their claims likely do not qualify under 11 U.S.C. § 507(a)(4). The priority in Section 507 is primarily for individuals and does not extend to prepetition unsecured claims based on a creditor's "critical" status. Section 105 empowers bankruptcy courts to issue necessary orders to enforce the Code, while Section 1107 grants debtors in possession trustee-like rights to operate the business. The "doctrine of necessity" allows for critical vendor payments to support business operations under § 1108, but the exercise of powers under § 105 must align with the Bankruptcy Code. Lastly, Section 362(a)(6) prohibits any actions to collect pre-bankruptcy claims, reinforcing the automatic stay provision.